Published on August 28th, 2020 📆 | 6372 Views ⚑0
The Technology Factor Behind Banks’ Q2 Earnings
CEO of IPC, a technology and service leader powering the global financial markets.
From the outset, it was clear the Covid-19 pandemic would create challenges for the global economy. Quarantines and other public health measures resulted in many businesses — large and small — either closing or experiencing significant financial distress. Prominent names such as Hertz, J. Crew, Chesapeake Energy and Brooks Brothers have all filed for bankruptcy, with likely more to come.
With the unprecedented downtick in the economy, there was great interest in major banks’ recent second-quarter earnings results, as it was the first full quarter impacted by Covid-19. In anticipation of the pain, banks preemptively set aside tens of billions of dollars in loan loss provisions ahead of future expected challenges.
However, in some ways, the opposite happened, as by and large, the earnings of big banks exceeded estimates. Goldman Sachs’ outperformance was its largest in nearly a decade, and other institutions such as JPMorgan and Citigroup also exceeded Wall Street’s expectations. What happened?
Essentially, it was a tale of two quarters. As big banks are composed of many disparate parts, different groups within the banks had widely varied results. The results of traditional consumer and commercial lending activities were actually about as bad as feared. For example, consumer banking revenues at JPMorgan Chase, Wells Fargo and Citigroup were down 7%, 26% and 9%, respectively, in the second quarter. As the pandemic triggered the shutdown of many firms and historical rates of unemployment, fewer people and businesses were in a position to borrow money or meet credit obligations. Furthermore, the current near-zero interest rate environment makes it much more challenging for banks to profit from lending activities.
Yet despite the numerous headwinds, trading revenues spiked dramatically, offsetting decreases in lending at most major U.S. banks. At Goldman, trading comprised 75% of its Q2 revenue, Citigroup saw a 70% year-over-year increase in Q2 trading revenue and JPMorgan reported a 79% YoY increase.
Why did the trading units fare so well? One overwhelming factor was extreme volatility. As the full impact of Covid-19 became clear, banks positioned themselves to go long volatility through measures such as buying funds and notes tied to the Volatility Index (VIX) — an index that appreciated throughout the first few months of the pandemic. Second, banks are often in a strong position to take advantage of price moves in equities and fixed income and were able to exploit spread imbalances accordingly. Finally, clients turned to the banks in droves for help in protecting themselves against market moves and facilitating trades, which led to additional volume-based revenue.
Another fundamental driver behind the trading profits is the evolution of platforms and technology tools for professional investors. Though not quite as visible as other factors, the evolution of complex and flexible trading platforms unfailingly supported trading during a period of uncertainty and wild market swings, coupled with huge volumes. It is truly incredible that Wall Street was able to manage through this crisis and generate record trading profits during a period when the vast majority of traders were forced to work from home.
Cloud technology has been another effective enabler for big banks in recent months. Previously, regulatory restrictions had limited the ability of professional traders to work remotely, but policymakers wisely understood the need to establish systems that are reasonably designed to supervise people working from alternative locations. The pandemic has accelerated the adoption of the cloud and undeniably brought its benefits to the fore. Given that voice trading plays an essential role during times of market turbulence, traders, in particular, have been able to effectively harness the power of cloud-based communications to their advantage.
While there are still wrinkles to trading remotely, like ensuring one’s baseline internet connection is sound, the shift to the cloud and remote work in finance has been much more than a tactical response and represents a long-term shift in how trading floors should evolve toward greater interoperability, flexibility and scalability.
In summary, the industry is well-prepared for the future, as the crisis has demonstrated Wall Street’s foresight and ability to constantly innovate.